Malta's insurance sector would see its assets-over-liabilities ratio fall if the country were to experience a protracted period with extremely low interest rates, a stress test has suggested.
The analysis by the financial regulator suggests that the positive impact such a scenario would have on bond prices would not completely offset the decline experienced in other asset classes, such as equities and collective investment undertakings.
The Malta Financial Services Authority said it developed the stress test framework as part of its risk management toolset for the local insurance sector.
Its framework envisages a scenario when interest rates remain extremely low for a protracted period, which could lead to a deterioration in corporate bond yields and equity prices.
That, in turn, would affect insurance companies’ investments – and ultimately balance sheets.
The exercise showed that domestic insurance undertakings, under the post-stress scenario, would incur an overall 7 percentage point drop in their assets-over-liabilities ratio in comparison with the baseline scenario.
The post-stress ratio of 108% is derived from a -1.7% drop in assets and a 4.9% increase in liabilities.
Stress tests are a tool used to measure resilience to severe but plausible events. The technique has become widely used within the financial sector as a risk management tool.
The MFSA added that, as a financial sector supervisory tool, it is considered useful to identify pockets of vulnerabilities and is increasingly being used in addition to the more conventional risk analysis techniques.
Stress test results should not be strictly interpreted in terms of institutions passing or failing, but rather to highlight possible sectoral vulnerabilities that could emerge, should such adverse movements on the financial market materialise in the future.
The MFSA test covered a mix of life, non-life and composite insurance undertakings that operate predominantly in the domestic insurance market and information was sourced from data available at the MFSA.
The exercise assumed that no immediate adjustments were made through management interventions, and the institutions are assessed on a stand-alone basis, that is, without allowing for any support within a group structure, including a parent company.
The MFSA said the methodology could serve as a guide to the industry to understand better the way the authority is analysing sectoral risks from a financial stability perspective.
Possible enhancements include further development of the methodology, primarily to enhance the process used in generating the stressed scenarios, and capture changes arising in the solvency capital requirements, it said.